The Short Straddle: Betting on Inaction

The short straddle is an options strategy that is used for a quiet market. It entails unlimited risk. It is also known as a credit spread. A credit spread is one where you receive premium at the opening of the position, as opposed to outlaying premium in the form of cash. Therefore, this requires a margin account.

With that said, let's explain the dynamics of the short straddle. Like any other options strategy, it is replete with a maximum loss, maximum gain, and break even price.

How It works

Constructing a short straddle involves selling both put and call options with the same exercise price. The break even price would be the premium minus the exercise price or the premium plus the exercise price.

The maximum loss is unlimited. The maximum gain is the premium received at time of trading minus any transaction costs.

In example, take a stock that is in a seasonally slow period, like the Dow Jones during summer months. It might be a good idea to sell a straddle for the summer months in order to receive a lot of premium. However, since the strategy entails unlimited risk, it is best to consider other strategies that are limited risk in nature.

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